Why pensions are an important asset during a divorce

Pensions are one of the most valuable matrimonial assets. They need to be given serious consideration when negotiating a financial settlement within divorce proceedings. Despite their value, a pension is one matrimonial asset that is often overlooked and in some extreme cases, ignored, when spouses negotiate a financial settlement upon divorce. This is because many spouses fail to seek proper legal advice because of the cost of doing so, or because they are not financially savvy, or because they may be easily influenced by their more domineering spouse. More commonly, one spouse, often the wife, may have sacrificed building up their own pension provision for retirement, because they stopped working, or undertook part-time work, to raise a family. This can lead to huge financial prejudice later in life.

Research by the University of Manchester found in about half of couples with pensions, one partner has 90% of the pension wealth. However, an estimated 71% of divorcing couples overlook pension sharing, despite private pension wealth often being one of their largest assets. In the majority of cases, it is the woman who loses out.

For this reason, it is imperative that spouses (not just the financially weaker party), seek advice, in relation to their pension entitlement upon divorce, from a specialist family law solicitor and/or a pensions expert, before agreeing a financial settlement with their former partner.

How are pensions dealt with in divorce?

Pensions can be dealt with by way of pension sharing orders, pension attachment orders (much less common) or offsetting orders.

As mentioned above, it is not unusual for one spouse to have a larger pension fund than the other. That is not a problem, if the couple remain married. However, if they separate and subsequently divorce, the spouse with no or little pension provision, needs to ensure that they are properly protected in their old age, by receiving a share of the other spouse’s pension.

It is possible, within divorce proceedings, for spouses to share pension funds, by agreement, or in the absence of agreement, by order of the court. A pension sharing order obliges the pension trustees to transfer a share of their member’s pension, to a pension fund in the other spouse’s name. That spouse will then have control over their own pension fund and be able to access it themselves after the age of 55 years.

How is the value of a pension calculated on divorce?

Spouses involved in divorce proceedings must exchange financial disclosure, including information confirming the value of their pension funds, often referred to as the transfer value, or cash equivalent value (CEV). In practice, questions may need to be raised of the disclosed fund value because, in many cases, the true value of the pension may be significantly more than the CEV suggests. For example, the value of many final salary pensions, such as NHS, armed forces, police and Civil Service pensions, are often significantly more valuable than the stated transfer value would suggest.

For example, the complex nature of an armed forces pension scheme can mean that the cash equivalent value may be misleading. This is because the CEV of an armed forces pension today, may not take into account any early departure payments, lump sums and/or bonuses the pension holder may be entitled to receive in the future. The value of these type of pensions can increase dramatically when these factors are taken into account. If they are ignored, the spouse entitled to a pension share will be significantly financially prejudiced.

In other cases, the CEV may be misleading because it does not take into account the fact that tax will be payable on 75% of the pension. For this reason again, it is important to receive specialist advice on pensions, especially when they are particularly valuable.

The house or the pension in divorce?

An entitlement to receive a pension share can be offset against other assets. For example, if one spouse is keen to keep another asset, such as the family home, but this comprises a significant share of the overall value of all matrimonial assets, that spouse may decide to offset some or all of the value of their pension share. Therefore, the person who retains the benefit of the pension will receive less of the liquid capital, such as the equity in the home. This is known as offsetting. Again, it is important to have proper advice, as to what offset calculation is appropriate. An actuary may need to be instructed to advise on this discrete issue.

In some cases, even where pensions are not being shared, they can be used to provide an income for both spouses in retirement, with maintenance being paid from pension income (a pension attachment order). However, pension attachment orders are much less common than pension sharing orders nowadays, particularly as a pension attachment order comes to an end on the death of the pension scheme member. The rules for pension attachment are different to pension sharing and again, the appropriate pension advice should be obtained.

Pensions are also a useful tool when a divorcing couple are close to retirement age. For example, they may choose to take a tax-free lump sum sooner than they originally planned, to release capital to rehouse one or both of them. A pension sharing order can be made afterwards, to provide an income stream for both parties if appropriate. Again, it is important for both parties to have financial advice if this option is being considered.

In some cases, it may be (but often is not!) possible for a spouse to exclude some pension funds (or part thereof) that accrued outside of the marriage – before marriage or post separation – from the matrimonial assets to be divided, particularly if a sharing of those pensions is not required to meet the other party’s needs.

To conclude, the importance of pensions should never be overlooked or ignored, in any divorce settlement. When a pension is a matrimonial asset, often a significant one, it is essential to consider whether offsetting, pension sharing or pension attachment is the most appropriate option, taking into account the particular circumstances of each spouse.